Warren Buffett’s communication style may be quirky at times, but his fans and followers still hang on every word. Whether he’s talking about investing fundamentals or his view of the future, Buffett is usually on point. For that reason, his characterization of the bond market in a recent letter to Berkshire Hathaway shareholders shouldn’t go unnoticed.
Bonds are not the place to be these days.
— Warren Buffett
To be clear about the context, Buffett was not offering up personal investment advice when he shared his negative outlook on bonds. He was instead providing detail on the competitive advantages of Berkshire Hathaway’s insurance brands. One of those advantages is his company’s ability to invest more heavily in equities than its competitors, which are stuck with either dismal Treasury yields or riskier forms of debt.
But Buffett’s point about the state of the bond market is a valid one. As the Oracle of Omaha notes, the yield on a 10-year U.S. Treasury bond has fallen from the double-digits in the 1980s to less than 1% at the end of 2020.
Treasury yields in flux, but still low
Things are looking a little better for Treasuries so far in 2021. The 10-year Treasury yield, for example, has moved up to about 1.5%.
That increase is likely driven by the investment community’s expectations for economic growth and rising inflation to appear later this year. Both of those conditions encourage bond investors to sell, either because they make the outlook for equities more positive, or because they want higher yields when they expect inflation to erode bonds’ future values.
Still, a 1.5% or even 2% yield on a 10-year instrument isn’t terribly exciting. As well, yields on Treasuries with shorter maturities remain very low — about 0.8% for 5-year and 0.08% for 1-year maturities.
Two Treasury alternatives
Treasuries do have a stabilizing effect on your portfolio, and that’s why they’re still in demand even when their yields are low. But the tradeoff is that too much exposure to low-yield government bonds restricts your portfolio’s overall growth potential. Fortunately, there are other ways to balance risk and return — such as dividend stocks and cash deposits in high-yield savings accounts.
Dividend stocks carry substantially more risk than Treasury bonds, because share prices rise and fall. Even so, longtime dividend payers are some of the stock market’s most stable companies. They tend to have strong balance sheets and relatively reliable cash flows. Many also deliver dividend yields in the 1% to 3% range, along with the opportunity to see gains from share price appreciation.
Three examples of companies that have been doling out dividends consistently for decades are Walmart (NYSE:WMT), Colgate-Palmolive (NYSE:CL), and Coca-Cola (NYSE:KO). Walmart yields 1.7%, Colgate-Palmolive yields 2.3%, and Coca-Cola yields about 3.1%.
You could invest in these and other dividend payers directly or find a low-cost ETF like Invesco Dow Jones Industrial Average Dividend ETF (NYSEMKT:DJD) for easy diversification.
High-yield savings deposits
A position in dividend-paying stocks is less liquid than Treasury bonds — mainly because you may not want to sell a stock if its price has dropped and you think the decline is likely to be temporary. You could manage that liquidity risk, though, by holding extra cash in a high-yield savings account alongside your dividend payers.
According to The Ascent (a sister site of the Motley Fool), the highest-paying savings accounts are offering interest rates of about 0.6% this month. That’s competitive with shorter-term Treasuries. Your deposit would be FDIC-insured, too.
Not the only game in town
Most investors, even Buffett himself, will benefit from some exposure to Treasuries. But government-backed debt isn’t the only way to stabilize your portfolio. You can refine your risk, return prospects, and liquidity by holding mature dividend payers and cash deposits, alongside your growth and Treasury positions.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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